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The Long-Term Fundamental Case for Gold.

February 27th, 2012 · Chris Vermeulen · 12 Comments

A quick glance at most of the headlines over the weekend and the primary focus seemed to be either calling a near term top in domestic equity indices or a focus on the Greek debt situation. Why is anyone even paying attention to what is going on over there? Until the ISDA declares a default where the underlying Credit Default Swaps (CDS) are triggered, it is all just noise.

The ECB has broken the rule of law by placing itself as the senior creditor ahead of private creditors, the Greek government is trying to pass retroactive legislation to trap private sector creditors holding out of the PSI, and the leader of Greece was not even elected by the people of Greece – how much more manipulation and insanity do we need to monitor?

Similar to the price action since 2008, central banks around the world control everything from financial markets to the ascent of political leaders. These same political leaders help central bankers and planners control policy and decision making at the highest government levels in Europe and around the world. It would seem that the United States should change the motto from “We the People” to “We the Bankers.”

However, there is one particular asset class that even the central bankers have a hard time controlling. While they can impact short term price action through direct currency manipulation initiatives, in the longer-term gold is likely to move in only one direction – higher.

The price action on Tuesday reminded market participants that actions such as the Greek bailout come at a cost. Quantitative easing and/or printing money (depending on what one wishes to call the practice of producing fiat currency out of thin air) has a direct impact on the price of gold.

Many financial pundits argue that gold has no utility, but what they fail to recognize is that gold is the senior currency to all other fiat currencies. Silver is also a form of currency and is senior to all other fiat currencies as well. While one can draw the utility of gold into question, the idea that gold is the senior most currency to all other fiat currencies is not new.

The Constitution of the United States of America, which is over 200 years old, refers to gold and silver as forms of payment.  Looking back thousands of years the Romans used gold coins as a form of currency. The idea that gold and silver are currencies is certainly not a grandiose thought or a stretch of historical concept. Trying to depict gold as a worthless asset depends on your view and consideration of fiat currency.

There are those that would argue that the Federal Reserve of the United States is not actively manipulating economic conditions domestically or abroad. For those that view gold as a poor investment or hedge against currency devaluation need to consider the charts illustrated below. The chart below was produced by Thomas Gresham of Gresham’s Law.

Total Asset Growth of the Federal Reserve System – 1915 – 2012


It is rather obvious by looking at this chart that the Federal Reserve has actively sought to enter domestic and foreign financial markets. The surge in balance sheet assets serves to prove how far the Federal Reserve Bank is willing to go to maintain markets which seemingly are only allowed to move higher over time.

This chart is bearish for nearly any form of paper backed assets. The above referenced chart is long-term bearish for the Dollar and Treasuries and long-term bullish for physical gold and silver. As the Federal Reserve continues to debase the U.S. Dollar in concert with other central banks’ monetary easing programs, gold and silver prices over time are destined to move higher in virtually every form of fiat currency.

During the same time frame that the Federal Reserve has seen its balance sheet grow exponentially, the rapid rise of M2 money supply is staggering. The long term chart of M2 is compared to gold futures in the charts presented below.

M2 Money Stock



Gold Futures Monthly Chart


It is rather obvious what has happened to the price of gold as the M2 money supply has grown. The idea that the Federal Reserve has not already destroyed a significant amount of the purchasing power of the Dollar can easily be refuted by the two charts shown above.

In the short-term, gold and silver could suffer from a pullback, but in the intermediate to longer term it is unlikely that we have seen the highs of this bull market for either metal. As long as central banks around the world continue to print money and expand their balance sheets gold and silver will remain in a long-term bull market. The daily chart of gold futures is presented below.

Gold Futures Daily Chart


As can be seen above, it is not out of the question that we could see gold pullback to test one of the key moving averages in coming days/weeks. However, I expect the key support area to hold in the event of a sharp selloff. Ultimately, I expect to see a breakout over the resistance zone in the days/weeks ahead. However, I would not be surprised to see gold consolidate or work marginally lower from current prices before breaking out to the upside. Right now the primary threat in this fledgling gold rally is a short-term spike higher in the U.S. Dollar. The primary catalyst which could drive a flight to the Dollar involves the sovereign debt situation in Greece and the Eurozone as a whole.

While the short-term price action may be bearish, the intermediate to longer term time frames are quite bullish for metals as central banks will continue to race to debase their currencies. Quantitative easing in the U.S. and around the world will become pervasive and gold prices could potentially soar in value. The data from the Federal Reserve Bank itself suggests that they are indeed increasing the money supply. As time has passed, the money supply and gold have seemingly grown in lockstep with one another. Surely inquiring minds do not consider this mutual relationship between gold and the money supply to be purely coincidental.

As further evidence that the Federal Reserve continues to use quantitative easing to manipulate asset prices through direct entry into financial markets, a chart of the velocity of M2 clearly depicts that the velocity of money is declining. I am not an expert regarding macroeconomic data, but if the velocity of money is declining to 1960’s levels would it be a stretch to say that we may be going through a period of stagflation? The chart below illustrates the Velocity of M2 Money Stock courtesy of the St. Louis Federal Reserve Bank.

Velocity of M2 Money Stock


For those unfamiliar with the term velocity of money, it is simply the rate of turnover in the overall money supply. The velocity of M2 is expressed as the number of times that a Dollar is used to purchase final goods or services which are included in the total gross domestic product.


The short term technical picture in gold is a bit suspect due to overhead resistance and recent U.S. Dollar strength. However, the longer term macro factors that impact the value of the U.S. Dollar and precious metals are all telling us the same thing.

As time wears on and central banks do even more to prop up the broader economy and failing financial institutions, it is without question in my mind that gold and silver will both benefit handsomely from these decisions being made by central bankers from around the world.

Ultimately, I am very bullish of gold and silver in the intermediate to longer-term, but in the immediate short-term frame gold could consolidate or pullback before breaking out to the upside.

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12 responses so far ↓

  • 1 Evolve // Feb 28, 2012 at 11:44 am

    Well, here is this: they can not not to bail Greece out. That would mean the failure of EU in general and Euro as a currency in particular. If before Euro Greece would just denominate its own currency and make the investment and tourist climate very attractive, you can’t do that in the euro zone any more.

  • 2 Trading Coach // Feb 28, 2012 at 12:12 pm

    There is another article about how gold as an investment does not really produce anything else. Warren Buffett proves in that article that stocks, farmland and cash are a better investment than gold. While there is so much interest in this metal, I see the picture that Buffett is trying to show.

  • 3 Lachlan // Feb 28, 2012 at 6:14 pm

    Get yourself some gold TC, it’ll put hairs on ya chest.

    Ha ha, my fisherman/viking uncle advised me like so in regard to scotch whisky… but as an eight year old I didn’t handle it too well.

    Seriously though, Warren should know that USD’s have lost much purchasing power in the US over the last ten years in particular while gold’s exchange rate for USD’s has increased six times. There are friends of family who live in New York who complain about the inflation there regularly.

  • 4 Lachlan // Feb 28, 2012 at 6:26 pm

    Sorry, the USD’s exchange rate for gold has increased…granted we have to weigh this against previous slack periods and the price fixing via various means is always a problem, however over a hundred years the trend is apparent. I guess it’s fair to say that gold valuations over short periods are no sure thing.

  • 5 Greg Atkinson // Mar 1, 2012 at 10:29 am

    I have written about how most gold is now going into vaults where it is waiting to be sold at some point. Seems to me investors in gold are relying now on more investors to keep buying gold which they will also park in a vault in order to keep moving prices higher. Sounds very speculative to me.

  • 6 Lachlan // Mar 1, 2012 at 5:24 pm

    Gold is no longer cheap Greg. I’ll grant you that.

    I concur in with you in to regard sovereigns forfeiting gold to pay debts, however I don’t think it will find itself on the open market. See Greece for example where creditors now have claim to gold. The primary gold risk I see is current Australian legislation that allows confiscation (albeit with cash remuneration). Also any changes in tax rules are possible.


  • 7 Plornt // Mar 7, 2012 at 7:20 am

    “I have written about how most gold is now going into vaults where it is waiting to be sold at some point. Seems to me investors in gold are relying now on more investors to keep buying gold which they will also park in a vault in order to keep moving prices higher. Sounds very speculative to me.”

    Well you have gotten your gold call correct Greg. System is short gold; statistical support is 1,600. I am not short gold though, and only long silver. There are good arguments as to why it is speculative, and you have raised them. In terms of a speculative bubble only 1% of the general public own gold; its difficult to say there is irrational exuberance with such a low participation figure. You could argue that with only 1% of the population owning gold, and governments printing money excessively; potential sovereign defaults etc that there will be plenty of greater fools to raise prices even higher given the low base already. I donot believe it is speculative and have a system for determining the intrinsic value of it, but I am aware of the other camps views and respect them.

    That said I expect the price to go range bound and be very volatile for the next 12-18 before the next parabolic rise.

    This drivel should not be taken as financial advice. Seek to obtain professional
    advice before proceeding with any financial decision.

  • 8 Greg Atkinson // Mar 7, 2012 at 7:50 am

    Plornt I can see why you prefer silver. What is driving silver prices appears to me based more on good old demand rather than speculation and parking the stuff in vaults 🙂

    I keep thinking to what point will those holding gold instead of say USD make the switch back or move into asset classes?

  • 9 Lachlan // Mar 7, 2012 at 9:20 am

    The internet is rife with peak silver arguments and it seems like a no brainer but I’ll just add that to my list of possible reasons to own it. Silver does look good that way, can’t say the same about gold. The chief reason I can believe in gold having more upside is because I think it will be part somehow of a new global monetary paradigm…not necessarily an age of increased freedom either as some bugs believe. As the ultimate extinguisher of debt it stands in line as chief beneficiary in this age of runaway debt issuance. The gold risk I see is political (government taking action against holders), not a risk to gold exchange rates.

  • 10 Stillgotshoeson // Mar 7, 2012 at 1:50 pm

    Greg Atkinson // Mar 7, 2012 at 7:50 am

    I keep thinking to what point will those holding gold instead of say USD make the switch back or move into asset classes?

    Around 2016/2017 I would expect a large gold sell off from what will be a much higher price than the current price.

  • 11 Plornt // Mar 10, 2012 at 4:44 pm

    Good interview with Roger Mongtomery about the effects of printing money; inflation and gold prices.
    I think he is spot on.

  • 12 Market Madness // Mar 15, 2012 at 11:05 am

    There can be little doubt in the current environment that gold has a bright future ahead of it. Barring a nearly unimaginable abrubt reversal in fiscal/monetary/economic policy, worldwide, we should continue to see the gold price trending upwards. Probably eventually even ending in a parabolic move before it is all over.

    In the immediate future, however, we could have a different story. Gold very well may come under additional pressure in the near future from pre-QE intervention, or simply well managed expectations. For “stackers,” physical gold holders, this is of no concern. Stay cautious if you speculate though.
    Market Madness
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